Differentiated and College Differentiated and College EconEcon

The Business Firm and Market The Business Firm and Market StructureStructure

The Three Types of The Three Types of Business OrganizationBusiness Organization

• Sole ProprietorshipSole Proprietorship• PartnershipsPartnerships• CorporationsCorporations

Sole ProprietorshipSole Proprietorship

• If you alone own If you alone own and control the and control the service.service.

Opportunity Benefits of Opportunity Benefits of Sole ProprietorshipsSole Proprietorships• Owner has direct Owner has direct

controlcontrol• Small initial Small initial

investmentinvestment• Owner receives Owner receives

all profitsall profits• Owner can Owner can

dissolve business dissolve business when necessary.when necessary.

Opportunity Costs of Sole Opportunity Costs of Sole ProprietorshipsProprietorships

• All losses are borne All losses are borne by ownerby owner

• Difficulty in raising Difficulty in raising financial capitalfinancial capital– Limited growth Limited growth

potentialpotential

• Only one person in Only one person in authorityauthority

• Lack of longevityLack of longevity• Unlimited liabilityUnlimited liability

PartnershipsPartnerships

• A business owned A business owned and controlled by and controlled by two or more two or more people.people.

                                                   

     

REMEMBER!REMEMBER!• Partnerships don’t Partnerships don’t

have to be just have to be just two people.two people.

• JC Penney: The JC Penney: The man with a man with a thousand thousand partners.partners.

Two forms of partnershipsTwo forms of partnerships• General General

Partnerships: Equal Partnerships: Equal decision making.decision making.

• Limited Partnerships: Limited Partnerships: Partners join as Partners join as investors, offering investors, offering capital, but little, if capital, but little, if any, role in decision any, role in decision making.making.– VENTURE VENTURE

CAPITALISTSCAPITALISTS

Advantages of Advantages of PartnershipsPartnerships• Two or more Two or more

individuals own the individuals own the business.business.– SpecializationSpecialization

• Losses are shared by Losses are shared by partners.partners.

• More money is More money is available to invest in available to invest in businessbusiness

• Sharing Sharing management management responsibilitiesresponsibilities

• Taxes are shared by Taxes are shared by partnerspartners

Disadvantages of Disadvantages of PartnershipsPartnerships

• Division of authorityDivision of authority• Unlimited liability.Unlimited liability.• Difficulty in raising Difficulty in raising

additional capital.additional capital.• Lack of longevity.Lack of longevity.• Legal complications Legal complications

when there is a when there is a change in ownership.change in ownership.

Advantages of Advantages of CorporationsCorporationsLimited liability.Limited liability.Easy to raise needed Easy to raise needed

capital.capital.Business owned by a group Business owned by a group

of individuals.of individuals.Responsibilities for running Responsibilities for running

the business divided the business divided among many individualsamong many individuals

Easy change in ownership Easy change in ownership and business continues and business continues as long as it makes as long as it makes profits. – LONGEVITY.profits. – LONGEVITY.

Disadvantages of Disadvantages of CorporationsCorporations

• Corporate Corporate charters are $$$charters are $$$

• Federal and state Federal and state govts. monitor govts. monitor corporations corporations more.more.

• ***Slow process ***Slow process of decision of decision making.making.

CorporationsCorporations• Legally distinct from Legally distinct from

their owners and their owners and treated as if treated as if individuals.individuals.– Corporations canCorporations can

• Own propertyOwn property• Hire workersHire workers• Make contractsMake contracts• Pay taxesPay taxes• Sue and be suedSue and be sued• Make and sell Make and sell

products.products.

CooperativesCooperatives

• Business Business associations of associations of producers and producers and consumers.consumers.

CooperativesCooperatives• Co-ops – Co-ops –

businesses owned businesses owned by their members. by their members. – Membership gives Membership gives

privileges.privileges.

CooperativesCooperatives

Nonprofit OrganizationsNonprofit Organizations• Does not focus on Does not focus on

financial gain and financial gain and profits. profits.

• Business Business organization but organization but pursues other pursues other goals.goals.

• Income isn’t Income isn’t taxed.taxed.

Functions of Business Functions of Business FirmsFirms

• Identifying consumer wantsIdentifying consumer wants• Organizing productionOrganizing production• Allocating revenueAllocating revenue• Real capital investmentReal capital investment

Identifying Consumer Identifying Consumer WantsWants

• Business firms Business firms determine what to determine what to produce on the produce on the basis of consumer basis of consumer wants.wants.– Consumer Consumer

sovereigntysovereignty

Organizing ProductionOrganizing Production

• Firms decide what Firms decide what mix of the factors mix of the factors of production will of production will best achieve the best achieve the desired output.desired output.

Allocating RevenuesAllocating Revenues

• Firms allocate Firms allocate their revenues to their revenues to pay company pay company employees, employees, suppliers, and the suppliers, and the investors.investors.

Real Capital InvestmentReal Capital Investment

• Firms increase the Firms increase the stock of real stock of real capital by capital by investing in plant investing in plant and equipment.and equipment.

NOT ON THE CHAPTER NOT ON THE CHAPTER TESTTEST

BUT WILL BE ON THE FINAL BUT WILL BE ON THE FINAL CRTCRT

Forming a corporationForming a corporation• When expansion When expansion

calls for more calls for more than adding more than adding more partners.partners.

• GET A LAWYER!GET A LAWYER!

Forming a corporation:Forming a corporation:• Lawyer applies for Lawyer applies for

a state license: a state license: ARTICLES OF ARTICLES OF INCORPORATIOINCORPORATION.N.

• Reviewed by state Reviewed by state officials. If all in officials. If all in order they grantorder they grant– CORPORATE CORPORATE

CHARTERSCHARTERS

Corporate StructureCorporate Structure• The corporate The corporate

charter identifies charter identifies the officers.the officers.– Chairman of the Chairman of the

board – symbolic board – symbolic head of the head of the corporation.corporation.

– CEO – Chief CEO – Chief Executive Officer – Executive Officer – the REAL power.the REAL power.

Corporate StructureCorporate Structure• Board of Directors – Board of Directors –

people from inside or people from inside or outside the outside the company. company. – Key decision making Key decision making

body.body.• Decide on product Decide on product

lines.lines.• Hires / fires Hires / fires

corporate officers to corporate officers to do the day-to-day do the day-to-day running of the running of the corporation. corporation.

– Sees that boards Sees that boards policies are carried policies are carried out.out.

Corporate FinancesCorporate Finances• Most common Most common

way to raise way to raise money is selling money is selling STOCK.STOCK.– STOCK – STOCK –

represents represents ownership of the ownership of the firm. firm.

– Ownership is Ownership is issued in portions issued in portions called SHARES.called SHARES.

Corporate financesCorporate finances• If you buy 100 If you buy 100

shares of stock in shares of stock in a company, you a company, you own 100 pieces of own 100 pieces of that company. If that company. If that company has that company has a total of 10,000 a total of 10,000 shares available – shares available – you own 1% of you own 1% of the company. the company.

Why own stock?Why own stock?• DIVIDENDS – DIVIDENDS –

profits on your profits on your investment.investment.– PREFERRED PREFERRED

STOCK – STOCK – guarantees guarantees dividends.dividends.

– COMMON STOCK – COMMON STOCK – potential for potential for dividends.dividends.

Why own stock?Why own stock?• SOMETIMES can SOMETIMES can

make more make more money for you.money for you.

• The “fun” of being The “fun” of being involved with a involved with a corporation or a corporation or a product. product.

Benefits for stockholdersBenefits for stockholders• Flexibility of Flexibility of

ownership.ownership.• Limited liability.Limited liability.

– Can’t be sued for Can’t be sued for corporate corporate problems.problems.

– If the corporation If the corporation folds, you only folds, you only lose what you lose what you invested.invested.

– Private assets Private assets can’t be seized.can’t be seized.

The trade-offThe trade-off• Common stock Common stock

ownership allows ownership allows a “voice” on how a “voice” on how the company is the company is run.run.

• Preferred stock Preferred stock does not. does not.

IMPORTANT ADVICE TO FUTURE IMPORTANT ADVICE TO FUTURE CORPORATE HEADS!!!CORPORATE HEADS!!!

• ALWAYS hold or ALWAYS hold or directly control directly control 51% of your 51% of your company’s stock.company’s stock.

• OR have a lack of OR have a lack of control at annual control at annual shareholder shareholder meetings.meetings.

• You can lose your You can lose your job!job!

Other disadvantages!Other disadvantages!• If you own stock, If you own stock,

corporate profits corporate profits are taxed twice.are taxed twice.– You pay taxes as You pay taxes as

being a member being a member of the corporation.of the corporation.

– You pay taxes on You pay taxes on the profits / the profits / dividends you dividends you take.take.

– Likely to change.Likely to change.

The corporation raises The corporation raises moneymoney• If there are If there are

thousands of thousands of shareholders, there shareholders, there is enormous is enormous amounts of money amounts of money through the sale of through the sale of stock.stock.

• eBay has 6,643,058 eBay has 6,643,058 shares available.shares available.

Other ways corporations Other ways corporations raise $$.raise $$.• Corporate bonds.Corporate bonds.

– You loan your money You loan your money to the company.to the company.

– You DO NOT own the You DO NOT own the company.company.

– Repaid the principal Repaid the principal and the interest. and the interest.

• Principal – the actual Principal – the actual money borrowed.money borrowed.

• Interest – the price Interest – the price you gave to that you gave to that principal.principal.

Example of Corporate Example of Corporate BondsBonds• You hold a 1 year You hold a 1 year

$1,000 bond. $1,000 bond. • At the end of the At the end of the

year you are paid year you are paid back the $1,000 back the $1,000 principal AND the principal AND the 5% ($50) interest.5% ($50) interest.

Corporate CombinationsCorporate Combinations• Most corporations Most corporations

seek to expand.seek to expand.– Build new facilities Build new facilities – Legally combines Legally combines

with another with another enterprise.enterprise.• MERGERS!MERGERS!

Three types of Mergers Three types of Mergers (corporate combinations)(corporate combinations)

• HorizontalHorizontal• VerticalVertical• ConglomerateConglomerate

Horizontal CombinationHorizontal Combination• Buying up Buying up

companies companies involved in the involved in the same industry.same industry.

• THINK STANDARD THINK STANDARD OIL – John D. OIL – John D. Rockefeller.Rockefeller.

Horizontal combinationsHorizontal combinations• All the companies All the companies

merging do the merging do the same thing. same thing.

• Standard Oil: all Standard Oil: all the companies the companies Rockefeller Rockefeller bought, bought, processed oil into processed oil into gas.gas.

Vertical CombinationVertical Combination• A merger A merger

between two or between two or more companies more companies involved in involved in different different production phases production phases of the same good of the same good or service.or service.

• THINK US STEEL / THINK US STEEL / Andrew Carnegie.Andrew Carnegie.

Conglomerate Conglomerate CombinationsCombinations

• Merger of Merger of companies companies producing producing unrelated unrelated products.products.

• Subsidiaries.Subsidiaries.• Started in the Started in the

1960s.1960s.

Opportunity Benefits of Opportunity Benefits of CombinationsCombinations

• Efficiency – Efficiency – centralized centralized decision making.decision making.

• Potential lower Potential lower costs.costs.

• Easier to acquire Easier to acquire financial capital.financial capital.

Opportunity Costs of Opportunity Costs of CombinationsCombinations• Can lead to Can lead to

unemployment unemployment (don’t need to (don’t need to double the jobs)double the jobs)

• Reduced Reduced competition in the competition in the market place. market place. – MONOPOLIES.MONOPOLIES.

Part 2: Terms of BusinessPart 2: Terms of Business

THIS is on both the CRT and THIS is on both the CRT and the Unit Test!the Unit Test!

Terms of BusinessTerms of Business

• Fixed Costs Fixed Costs (overhead)(overhead)

• Variable CostsVariable Costs• Total CostsTotal Costs

Fixed CostsFixed Costs

• FIXED COSTS – FIXED COSTS – Costs that don’t Costs that don’t change month to change month to month.month.– RentRent– Loan paymentsLoan payments– SalariesSalaries– TaxesTaxes– Insurance Insurance

premiumspremiums

Costs of ProductionCosts of Production

DEPRECIATION – DEPRECIATION – lessening in value lessening in value of items over of items over time.time.

OVERHEAD – OVERHEAD – Another term for Another term for total fixed coststotal fixed costs

Costs of ProductionCosts of Production

• VARIABLE COSTS VARIABLE COSTS – Costs that – Costs that change as the change as the level of output level of output changes.changes.– WagesWages– ElectricityElectricity

Variable CostsVariable Costs

• LaborLabor• Raw materialsRaw materials• Other inputsOther inputs

COSTS OF PRODUCTIONCOSTS OF PRODUCTION

• TOTAL COSTS – TOTAL COSTS – sum of fixed and sum of fixed and variable costs.variable costs.

• Fixed Costs + Fixed Costs + Variable Costs Variable Costs = Total Costs= Total Costs

Diminishing ReturnsDiminishing Returns

• Additional units of Additional units of a VARIABLE input a VARIABLE input are added to one are added to one or more FIXED or more FIXED inputs.inputs.

• DIMINISHING DIMINISHING RETURNSRETURNS

Total RevenueTotal Revenue

• Price x QuantityPrice x Quantity

ProfitsProfits

• Total Revenue – Total Revenue – Total Costs = Total Costs = PROFITPROFIT

• P = TR - TCP = TR - TC

Average CostsAverage Costs

• TC / Q = ACTC / Q = AC

• Total Costs Total Costs divided by divided by Quantity = how Quantity = how much it costs for much it costs for each unit each unit (average)(average)

Economic ProfitsEconomic Profits

• Accounting profits Accounting profits are NOT ALWAYS are NOT ALWAYS a valid a valid representation of representation of the actual the actual earnings of a earnings of a business.business.

Economic ProfitsEconomic Profits

• A normal rate of A normal rate of return on the owner’s return on the owner’s invested capital is invested capital is included in costs included in costs along with the value along with the value of any labor of the of any labor of the owner in determining owner in determining economic profits.economic profits.

Accounting ProfitsAccounting Profits

• Total Revenue – Total Revenue – explicit costs = explicit costs = Accounting ProfitsAccounting Profits– Explicit CostsExplicit Costs – –

Direct costs of Direct costs of productionsproductions

– Implicit CostsImplicit Costs – – Opportunity costsOpportunity costs

Implicit CostsImplicit Costs

• Opportunity cost Opportunity cost of a proprietor’s of a proprietor’s labor and the labor and the NORMAL RATE OF NORMAL RATE OF RETURN on capital RETURN on capital invested in a invested in a business.business.

HUH?HUH?

• Implicit Costs – a Implicit Costs – a CEO gives up their CEO gives up their $2-million salary to $2-million salary to run a coffee service.run a coffee service.

• Normal Rate of Normal Rate of Return – how much Return – how much would the capital would the capital have made in the have made in the bank? Or rented to bank? Or rented to others?others?

How Does Industry Market How Does Industry Market Structure Affect Price and Structure Affect Price and Output DecisionsOutput Decisions

Rule of Business:Rule of Business:• The more The more

competitive the competitive the industry, the industry, the more the more the consumer consumer benefits.benefits.

Rule of Capitalism:Rule of Capitalism:

• Encourage Encourage competition competition between firms in an between firms in an industry (market).industry (market).– The consumer The consumer

benefits:benefits:• $$$$$$• Variety of productsVariety of products• Lots of information Lots of information

about productsabout products

Two types of markets are Two types of markets are highly competitive.highly competitive.

• Perfect Perfect competitioncompetition

• Monopolistic Monopolistic competitioncompetition

Conditions for Perfect Conditions for Perfect CompetitionCompetition

• Many buyers and Many buyers and sellers act sellers act independently.independently.

• Sellers offer identical Sellers offer identical products.products.

• Buyers are well Buyers are well informed about informed about products.products.

• Sellers can enter or Sellers can enter or exit the market exit the market easily.easily.

Monopolistic Competition Monopolistic Competition (Differentiated (Differentiated Competition)Competition)

• Differs in ONE key Differs in ONE key respect.respect.– Sellers offer Sellers offer

DIFFERENT, rather DIFFERENT, rather than identical, than identical, products.products.

Differentiated CompetitionDifferentiated Competition

• Large number of Large number of sellerssellers

• Nonstandardized Nonstandardized productproduct

• Ease of EntryEase of Entry• Production costs Production costs

are higherare higher– Packaging and Packaging and

advertisingadvertising

Shared Monopoly = Shared Monopoly = OligopolyOligopoly

• Only a few firms Only a few firms producing the producing the productproduct

• Barriers to entryBarriers to entry• Profits persist in Profits persist in

the long run.the long run.

Pure MonopolyPure Monopoly

• An industry in An industry in which there is which there is only one produceronly one producer

• The firm and the The firm and the industry are one industry are one and the same.and the same.

• Think UTILITIESThink UTILITIES